When it comes to deciding on a business structure, you need to consider a few factors prior to making your decision. While corporations, sole proprietorships, limited liability companies, and general partnerships are all options, limited liability partnerships seem to be an increasingly popular business structure for small business owners.
What is an LLP?
LLPs or limited liability partnerships are considered legal and flexible tax entities allowing partners to benefit from economies of scale by working together. At the same time, partners help reduce the liability for the actions of other partners. As is the case with many legal entities, you’ll need to check the relevant state laws prior to forming your LLP.
LLPs allow for a partnership structure where the partners’ liability is limited to the amount they put into the business. Therefore, you spread the risk by having business partners and leverage individual expertise and skills while establishing a division of labor. In the case of limited liability, if the partnership fails, then the personal assets or income of the partners is protected from creditors. Additionally, LLPs are common in professional businesses like accounting firms, law firms, wealth managers, and medical practices.
To better understand an LLP, you’ll need to understand the general partnership business structure. General partnerships are for-profit entities that are formed between two or more parties. In layman’s terms, it simply means that two more people come together to work together to make money. General partnerships are an informal business structure, and all you need is a shared interest in a business opportunity. Contracts are not necessary but can be implemented to safeguard the business.
Additionally, due to the informal nature of general partnerships, there are drawbacks. Legal liability is one of the most obvious risks, and in a general partnership, every partner shares in the liability for whatever issue that could arise in the future. The laws governing LLPs vary based on the state in which you’re forming the LLP. However, in most cases, your personal assets are protected from legal action, and while you may lose assets in the business, your personal assets are out of limits.
Who should start an LLP?
Considering the fact that there are multiple business structures available, why would someone want to form an LLP? One of the main reasons to form an LLP is for limited liability protection. This is because the limited partners are only at risk of the capital they put into the business, whereas general partnerships face unlimited liability. Therefore, if one of your main concerns is a liability, then an LLP may be the route to go.
Another reason to start an LLP is if you want to invest in assets that you can’t finance in your own personal capacity or you want someone to share the burden of cost. In this case, an LLP is a good investment opportunity. Individual investment risk is also circumnavigated in starting an investment LLP as the risks are split across all departments. LLPs are also only taxed once, as opposed to the double taxation of corporations.
Ultimately, the decision all boils down to what your state permits and what features of the business structure are most important to you.
Advantages of LLPs
As is the case with every business structure, limited liability partnerships offer various advantages. Let’s take a closer look at them below:
Each partner is personally accountable for the actions of the business. Therefore, liabilities, business debt, and wrongful acts of other partners may affect others. In the case of a limited liability partnership, partners are afforded liability protection. Therefore this type of business formation protects each partner from personal liability, and they are not held accountable for the negligent acts or decisions of other partners within the LLP. Additionally, individual partners cannot be held accountable or made to pay debts on behalf of other partners.
Another advantage of a limited liability partnership is the flexibility it affords you. Partners have the authority to or are entitled to decide how they will contribute to business operations individually. Likewise, the operations of the business can be equally divided or separated based on the experience and skills of each of the contributing partners.
Furthermore, a partner may elect not to have any type of authority over business decisions if they have a financial interest in the company. However, they’ll still maintain ownership rights based on their percentage interest in the business. But, it’s important to note that making decisions based on personal interests, although you are afforded flexibility can become a disadvantage.
Self-employment taxes, personal income taxes, and estimated taxes need to be filed by the individuals in the partnership. The partnership itself is not responsible or accountable for paying corporate taxes. Consequently, the deductions and credits of the business go to partners to file on their individual tax returns.
These deductions and credits are also divided by the percentage of individual interest that each of the partners have in the business. For partners that have a limited interest in the company or have special tax requirements, this can be beneficial.
Disadvantages of LLPs
LLPs do have some drawbacks as well. Let’s take a closer look at them below:
Special tax considerations
LLPs have extremely complex tax filing requirements. For this reason, the special structure of limited liability partnerships in some states by taxing authorities recognizes the structure as a non-partnership for tax purposes. For those partners requiring special tax consideration, this could prove to be a slight disadvantage. In fact, in some states, LLPs are prohibited altogether due to the tax complexities that are involved.
One partner can bind the other
Another disadvantage of LLPs is that partners are under no obligation to consult with each other in certain business agreements. Therefore, it is recommended that a partnership agreement (which is similar to an operating agreement) be drawn up in order to protect the overall integrity of the business.
The agreement should specifically outline what each limited partner may or may not do when it comes to the decision-making processes. It’s also a good idea not to disclose the financial statements of LLPs publicly as it may create an issue for certain partners.
Not recognized in every state
LLPs are not considered legal business structures in every state in the way that general partnerships are. Some states do not allow the formation of an LLP unless it is for professionals such as lawyers and doctors. Some states do permit the formation of LLPs. However, heavy tax limits are imposed on these types of business entities.
The tax limits are applied when forming the corporation and are also relevant to the ongoing costs of sustaining the business. LLPs are also perceived to have much less credibility as compared to corporations. In many cases, they are not regarded as “true” businesses.
Steps to starting an LLP
The following steps will help you form an LLP:
1. Choose a name for your LLP
The first step in registering your LLP is deciding on a business name. You need to ensure that another LLP is not using the business name in the state, and you also need to ensure that it doesn’t include state-restricted words. As a general rule of thumb, the words “bank” or “insurance” are prohibited for LLC entities.
The MCA or Ministry of Corporate Affairs is responsible for checking the LLP name and ultimately approving it. Check with your Secretary of State to ensure that there aren’t additional prohibitions when it comes to choosing LLP names.
2. File Articles of Organization
When filing Articles of Organization, ensure that it contains basic business information such as the name and address of your company as well as the details of all members. Reach out to the Secretary of State’s office to find out if you need to file the Articles of Organization with them or at another government agency such as the State Corporation commission.
3. Apply for a DIN
A DIN or Director Identification Number is a document that needs to be secured when starting an LLP. In order to obtain this number, you need to complete Form DIR – 3. You’ll also need to submit scanned copies of documents like PAN (Permanent account number) and TAN (Tax deduction account number) along with the form. This DIN Form needs to be signed by an advocate or chartered accountant.
4. Register digital signatures
Prior to LLP registration, you’ll need to submit additional signatures of at least two partners. Thereafter, these partners’ names will need to be affixed on the e-forms as per class 2 and class 3 of the digital signature certificates. The signatures may be obtained from the relevant authorized certifying agency.
Thereafter, the designated partner signatures must be registered on the Ministry of Corporate Affairs website. This is primarily because LLP documents are filed online, and the digital signatures of all proposed partners must also be done digitally.
5. Subscription document
On the subscription document, complete the Form and mention the total amount of capital contributed by each of the LLP partners. Additionally, the names of the witnesses, nominees, and partners must be submitted along with Form 2 and include the signatures of all the relevant members. An individual partner must consent when designated partners are nominated.
6. Obtain TAN and PAN
You’ll need to obtain PAN and TAN documents separately, online and offline. The application should be made to the income tax department.
7. LLP agreement
In accordance with the LLP Act, an LLP agreement must be made. The agreement must be filed within a period of 30 days of its formation, registration, or incorporation. This document includes the duties and rights of the partners. Therefore, an LLP agreement should contain the name and objective clause as well as the registered office of the limited liability partnership.
Additionally, it also needs to include the sharing ratio of profits as well as losses, details of designated partners, the remuneration payable to partners as well as the procedure for liquidating the LLP.
Partners of a limited liability company may be corporate entities or individuals. An LLP is available only to business structures that plan on making a profit. Therefore, the limited liability partnership LLP business structure is not intended or permitted for nonprofit organizations or charities.
An LLP offers protection for its owners. It’s also a formal structure requiring annual reporting depending on your legal jurisdiction. It’s different from an LLC due to its liability protections as well as management structure. When it comes to an LLP vs. LLC, the later structure still has more flexibility to manage the business, while LLPs require that management duties be divided equally.
The key difference between LLPS and LPs is that in a limited liability partnership, all partners have limited liability, meaning that they can take part in management activities. However, with a limited partnership or LP, there’s at least one general partner that has unlimited liability, and limited partners can’t be part of the management team.
Depending on the scale and scope of the LLP, you may or may not need to appoint a CEO. However, if you do decide to nominate a CEO, it may be done with the consent between partners to supervise the overall operations of the partnership. However, this decision is left completely to the partners.
One of the main characteristics of limited liability partnerships is that they are considered separate legal entities from their partners, thereby reducing exposure to liability. Additionally, LLPs must have at least two designated members responsible for ensuring that the LLP meets its obligations. Each member is also responsible for their own tax liability.